Macroeconomic and financial market commentary

Daily Archives: October 22, 2017

I can’t help it. The pervasive feeling of doom, I mean. Not that I should try to stop it: you must embrace that sentiment today. In the midst of a noisy, chaotic environment it is the only certain truth. Like in most pre-revolutionary times, our current situation is mostly made up of lies, lie-statistics and monopoly money aplenty.

Nevertheless, I do my best to remain optimistic. I have always considered myself a cheery individual trying to help build a better world -and make some money for my sail racing needs in the meantime. But it takes an increasingly vigorous effort to remain that way when you feel like in a financial death corridor -waiting for the hangman to appear any day. Reality is there for you to see. You can’t help casting a glance now and then. And it is indeed sobering.

We all know that the real economy is only hitting the apparently right numbers because of the continuous printing and credit aggregate increases (direct credit to consumers, or indirect credit using marginal sovereign credit and then entitlements paid out by those sovereigns). The next two charts by 720 global are very, very explicit -and fully back my previous assertion. Take your time with them.

The first chart shows why GDP growth of any kind fails to ignite aggregate demand moves. Fixing inequality in Disposable Income generation is not only a moral imperative. We need to do so to get the Walrasian equilibrium working again. This business model will not generate sustainable growth if it can’t generate sustainable aggregate demand.

But wait, if that first chart was appalling (growth is impossible), the second graph is shocking. It shows the precarious health of US aggregate demand after more than a decade of daunting inequality. We’re pondering US data, but figures are worse in entitlement land -Europe. Much worse.

The Walrasian equilibrium is already broken beyond non-disruptive repair. The system only works because CB’s inject external money or fresh credit (indirectly via the fractional banking system) on a daily basis. Supply no longer generates its own demand. Aggregate demand is markedly artificial. Nearly 50% of consumption is financed, not by supply-side generated disposable income, but by credit or entitlements. Immigrants unsurprisingly want to share the entitlement pie. It is a consequence of the entitlement-driven, aggregate demand led, economic model. A self-reinforcing negative loop of entitlement and credit led growth.

Things can get worse -and they sure will. Can you imagine the impact on aggregate demand of having to reduce pensions sometime in the not too distant future (to preclude state bankruptcies)? Just ask Greece how it felt. The developed world GDP will collapse. We survive because we go further in debt, rob savers of their income, curtail savings (never mind the funding disaster of most pension funds, private or public), and, not to forget, print. We print like there is no tomorrow. Fiat money debasement is the only reason for the real economy to keep chugging along. It is understandable that people are unable to see this. What’s surprising about it is that the standard mainstream economist is unable as well. They don’t want to see it. The establishment pays them well not to do so. Peak blindness is that of those who do not want to see.

And what do we get for all this artificial, unsustainable stimulus? Not much growth, or population satisfaction I’m afraid. To add to our woes, the ratio of money growth to economic activity keeps deteriorating. We need more and more monetary stimulus just to remain afloat. Jeffrey Snider keeps editing a chart that saves a thousand words.

Things are not better in the financial world. We are aware that financial market pricing is the result of a sophisticated fabrication process sponsored by global Central Banks. Everything is fake, market functioning is rigged, and fiat money is no longer a stable valuation tool for assets. Bitcoin and gold are in my view no robust, foolproof alternatives. We even know that our current itinerary is a direct course to economic hell: we cannot keep growing on new credit and freshly minted money, forever. But we like to see the sunny side of things: we feel that there might be some time left to enjoy. Like Saint Augustine, we plan to be chaste but not yet: lets print just a little more. Bull markets are adorable, aren’t they?

We pretend not to care much while listening to the Titanic orchestra in full splendor, but in truth we do. Jobs and pensions are a permanent concern to all. War to some of us. Many can’t sleep when they consider portfolio risks: put me in that lot. Only ETF and long-only fund managers can afford some decent sleep. They don’t care when this ends; they just have to keep a steady portfolio going. Easy for ETF managers, difficult for the long only’s, but nowhere near impossible. Unfortunately, timing Armaggedon is. The odds are stacked against you even if it is not a matter of “if” but only of “when”.

I keep on reading everything decent I can put my hands onto. We all sound like a broken record to some extent. Tell me the author and I can anticipate the content. Some insist in outlining, with surgical precision, the valuation case against financial markets at current levels (exquisite Hussman, a must read). His table with correlations for the different valuation parameters is excellent, despite underestimating the high validity of the Fed model (sarcasm alert). Valuations are atrocious.Other authors delve into the absurd real interest rate level suggesting the fixed income market is out of whack. Historical charts prove current negative real rates are incompatible with 2017 growth levels -however brittle that monetarily induced growth might be. I hand-picked one BlackRock chart for that end. There are lots more proving the same insanity. It’s just that aggregate demand is so sick that even this crazy monetary environment consistently fails to ignite severe inflation. And the money printing process feeds back on itself.

Both bonds and equities are a bubble. The mother of all bubbles if you consider the chart underneath (via zerohedge). Of course, there is always an alternative read to events. Maybe we have all been so smart that we have achieved the highest wealth to income ratio in history in just ten years. We have to thank Paul and Ben for that. Do we?Every single asset price is bubbly -unless you consider the currency debasement in the ROI calculations. Maybe your expected return is zero in real inflationary adjusted terms, but it pays to hold that asset if you know the real economic value of the currency (GDP/monetary base) is going down close to ten percent yearly (Japan, Europe 2016). The fact that goods and services inflation is contained helps hide the colossal debasement in the value of fiat in economic flow terms. Inflation is not the way to measure the value of money if we want to be coherent. Valuing wealth is 6.5 times more important than evaluating disposable income -according to the chart above.

A couple of pundits (more than two in Fedspeak), have brought back the goods and services pricing debate. They have a point. Inflation appears to be inching back after literally dying only a few months ago. Maybe it wasn’t as dead as I thought. Perhaps Yellen was right for once. The implications of a surge in inflation would be huuuge! Can we still generate inflation -regardless of the chronic state of decay of aggregate demand? If you want to delay chasteness, Saint Augustine style, we’d better not. If rates turn loose … that’s a game changer.

CBs should be careful about what they wish. A rapid rise in rates would wreak havoc in financial market pricing. The desperate search for yield has generated a 1.4 trillion short of volatility worldwide -according to Cole at Artemis. Part of that is an explicit volatility short (gamma short of option selling), and the rest is an implicit short. Investors unknowingly engineer strategies that are naturally exposed to the same risks as a short option portfolio.

While the situation is calm on the outside, the number of critical variables keeps growing. We have long been unable to afford a recession to uphold the debt sustainability paradigm. And we’ve had to be careful about interest rises and the increase in the cost of rolling over the debt pile for some time now. Now we have to worry about earnings leverage as well, as Corporates have overplayed the buyback engineering option to keeps eps growing (in a context where revenue is not). Lastly, in the last twist of events, we have to be terrified about a possible unwinding of the short volatility trade or the possible selling avalanche of the risk parity strategies if the VIX or bond volatility spike. Do you still think nothing will go wrong?

In the meantime, everything is awesome; we macro fund managers and other hedgies have all bought ourselves a beautiful Japanese sword. We will all die with dignity -like the last samurai. Matter of factly writing, before I forget, Kyle Bass is engaged in a new country short, Italy, after getting killed in China by the top manipulator ever: the PBOC. By the way, he is fundamentally right regarding both China and Italy -but I don’t think that’s relevant to his final fate. The PBOC and the ECB are.

Let’s be realistic: it does not. For as long as we can keep growing money and credit aggregates at no inflationary or socially disruptive cost, the show will go on.Bill Gross dubbed the ongoing process as “writing checks for free”, and that adequately describes the ultimate functionality of what we are doing.

We have all seen this game being played before, but not on a planetary basis. Charles Ponzi invented the game -and now it is a necessary exercise for money managers. Ignominy and final harakiri are your destiny if you are left out. Full Armaggedon someday if you play ETF investing.

All in all, it reminds me of “Le Choix de Sophie”. Less dramatic, for sure, but essentially the same kind of insurmountable choice. I can’t help that deeply melancholic feeling when listening to the song. It helps prepare for the ultimate harakiri moment for money managers -when bubble blowing goes eternal, and we have become entirely obsolete. Not that far away, I fear.

Regardless, I’ll keep waiting: the law of gravity will reassert itself at some point. If it can’t go on forever, it’s going to stop. I know it’s asking too much, but we need the patience of the fisherman and the resilience of Nelson Mandela. Will God provide?